The European Monetary System by Francesco Giavazzi, Stefano Micossi, Marcus Miller

By Francesco Giavazzi, Stefano Micossi, Marcus Miller

The ecu financial procedure has, on account that its inception in 1979, supplied a desirable instance of coverage coordination in perform. As crisis approximately exchange-rate instability and worldwide fiscal imbalances has grown, either educational researchers and coverage makers have regarded to the EMS for classes approximately cooperation on a much broader scale. This quantity comprises the papers and court cases of a convention prepared via the Centre for financial coverage examine in cooperation with the Banca d'Italia and the Centro Interuniversitario di Studi Teorici in step with los angeles Politica Economica. The convention introduced jointly exotic teachers and primary bankers providing a well timed precis of present learn at the ecu financial method, whereas the concluding panel dialogue presents a useful standpoint at the issues of policy-makers.

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The significance of these issues differs across countries, but the last is of outstanding importance for low-velocity countries such as Italy or the new entrants into the Common Market. 1) where x ratio of debt to GDP r real interest rate y real growth d non-interest deficit as percent of GDP n inflation a, /? parameters of the velocity equation The equation is derived by assuming that the part of the budget deficit not financed by highpowered money creation is financed by debt. Debt accumulation, relative to GDP, is thus determined by the two traditional terms: the non-interest budget deficit (measured as a fraction of GDP) and the discrepancy between the real interest rate and the growth rate.

Specifically, the case can be made that countries with a debt problem should most definitely not seek near-zero inflation. The inflation issue has a bearing on optimum currency areas. The traditional argument has focused on the (menu cost) advantages of a single money. The argument advanced here is more consequential. Public finance imposes an important constraint on the possibility of monetary unions. Countries for whom the efficient tax structure implies the use of an inflation tax - because the marginal cost of an extra dollar of resources raised this way is significantly less than that of raising (say) social security tax rates - should not merge with others for whom zero inflation is the policy objective.

2) for a role of inflation that immediately raises the following argument: an increase in expected inflation, given output and real balances, cannot explain a rise in real interest rates. Why? Because an increase in expected inflation, if it has any effect at all, reduces real money demand and hence must lower the nominal interest rate. It must therefore certainly reduce real rates. More generally, inflationary expectations can be a reason for high real interest rates only if they raise the level of economic activity, typically via an investment spending boom.

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